An Undervalued REIT for Risk-Tolerant Investors [VTR]

REITs are companies who own, operate or finance income-generating real estate. They were established by Congress in 1960 to “allow investors to buy shares in commercial real estate portfolios—something that was previously available only to wealthy individuals and through large financial intermediaries“.

REITs can provide you with stable annual income. Indeed, they are legally obligated to pay a minimum 90% of their taxable income as dividends. This usually leads to high dividend yields. However, they tend to generate modest capital appreciation because they can only invest 10% of their taxable income to purchase new holdings.

However, all REITs are not created equal. It is very important to analyze a REIT’s profile and finances to ensure that it is not only generating stable sources of income but also investing in growth to increase its future earnings.

Today, I will present a REIT that is a potentially risky investment. Now may be the time to purchase under-fire REITs with the potential to bounce back strongly once the market recovers. As always, these articles are not financial advice but merely investment ideas. You should conduct your own due diligence before investing in any asset.

COMPANY PRESENTATION

Founded in 1998 as a spin-off of Vencor, VTR is areal estate investment trust specializing in the ownership and management of health care facilities in the United States, Canada and the United Kingdom“.

With more than $36 billion in accretive investments since 2000, VTR states that its portfolio is “resilient, diverse and carefully-curated across asset classes, business models and strategic partners“.

In its 20+ years of operation, the company boasts: A $34 billion enterprise value; 22% compound annual total shareholder return since 1999; 96% private pay revenues; 7% FFO/Share growth since 2001; 10th consecutive year of dividend growth; 7% compound annual dividend increase; BBB+ Credit rating; and $2.6 billion liquidity.

PORTFOLIO

VTR’s real estate portfolio consists of 1,200 properties in the US, Canada and the U.K. It is composed of 61.5% Senior Housing Communities and 29.8% Medical Office Buildings. The remaining 8.7% of the portfolio is made up or research & innovation centers, skilled nursing facilities and international hospitals.

Its three largest tenants are Brookdale Senior Living Inc, Ardent Health Partners and Kindred Healthcare who lease 122 properties, 11 properties and 32 properties respectively” (page 1). Brookdale operates 800 living communities and has revenues of $4.97 billion; Ardent Health Partners offers rehabilitation, surgery, and retail pharmaceutical services and has revenues of $3 billion; and Kindred Healthcare is a post-acute healthcare services company that operates long-term acute-care hospitals with revenues of $6 billion.

Of its 1,200 properties, VTR says that “412 properties are under “triple-net” or “absolute-net” leases that oblige the tenants to pay all property-related expenses“. Triple-net leases are very advantageous for REITs because they lower operating expenses and ultimately boost the bottom line. However, approximately 65% of its leases are not triple-net so the company may have significant operating expenses.

VTR claims to be the “leading owner of university-based Research & Innovation (R&I) in the United States“. It owns “34 operating properties in 13 hub markets and has a $1.5 billion development pipeline“. Further, its “university partners are above the 95th percentile of National Institutes of Health (NIH) funding“.

CORONAVIRUS SELLOFF

VTR has seen its stock plunge 77% in just six months, going from $75.23 in September 2019 to a low of $16.97 in March 2020. The main reason behind this drop is its exposure to senior housing.

Since the coronavirus hits people aged 70 to 80 the hardest, investors fear that less seniors will move into homes and more will move out. Although the long-term demand for senior housing in the US will remain intact due to an ageing population, VTR and its senior housing operators will have to find ways to convince potential customers that its hygiene protocols are up to par to prevent the spread of viruses.

The other concern is that VTR not only leases the senior housing assets but also participates in the performance. This means that it feels the pain when times are tough. VTR recently released a statement saying that operating costs are increasing due to a significant number of seniors moving out of its facilities and that it expects this trend to continue in the near future.

VTR also drew$2.75B on its $3.0B revolving credit facility and withdraws its 2020 financial guidance due to the uncertainty surrounding the impact of the coronavirus“. To its credit, VTR is enacting proactive measures to ensure that it has sufficient liquidity to survive these turbulent times.

All things considered, I believe that VTR has the potential to weather the storm and bounce back.

REVENUE GROWTH

First, it is important to note that VTR’s finances are strong: Since 2016, Revenues are increasing, EBITDA is consistently above $1.7 billion and Net Income is consistently above $400 million.

2019 Net Income of $433 million is up 5.75% from 2018 but down 68% from 2017. Judging from the 2018 10-K Report, it appears that the drop in Net Income from 2017-2018 was due to a significant decrease in “Income from continuing operations”, which dropped to $415.9 million in 2018 from $1.3 billion in 2017 (p. 37).

2019 EBITDA of $1.8 billion is up 8% from 2017 but down 2% from 2017. This is not overly dramatic because it remains consistently above $1.7 billion and does not decrease significantly.

Operating Expenses are high due to only 1/3 of their rental properties being under net-lease contracts. The good news is that 2019 Gross Profit is 31.1%, up from 28.7% in 2018 and 28.6% in 2017. This means that VTR is able to control its costs to maintain profitability.

NOI & FFO

  • NET OPERATING INCOME (NOI)

NOI is the equivalent of Gross operating Income: VTR’s 2019 NOI of $2.051 billion is up 1.1% from $2.029 billion in 2018. All segments of NOI are increasing, with a notable 6.6% increase in office operations income.

However, we note a 27% decrease in “all other” NOI category. This is worrying but compensated by increases in the other segments. Perhaps, VTR is restructuring its operations to focus on its areas of expertise.

  • FUNDS FROM OPERATIONS (FFO)

To properly analyze a REIT, one must pay special attention to FFO. It is the best way to determine a REIT’s cash flow as it excludes depreciation and amortization, two charges that can be somewhat ‘manipulated’ with the help of a sophisticated accountant.

VTR’s 2019 Normalized FFO is $1.42 billion. VTR’s FFO is not increasing linearly: It was $1.3 billion in 2018, $1.5 billion in 2017, $1.4 billion in 2016 and $1.3 billion in 2013. Yearly FFO can vary according to cash used by investing and financing activities.

On page 50 of its annual report, VTR says that thedecrease in normalized FFO for the year ended December 31, 2019 over the prior year is due primarily to the $12.3 million fee received in the third quarter of 2018 related to certain 2018 Kindred transactions and 2018 loan repayments and fees“.

Overall, VTR’s FFO is stable and indicates strong sustained earnings from operations.

ASSETS & LIABILITIES

When looking at Current Assets, the immediate concern is the Current ratio of 0.37 which is appalling. Evidently, VTR has insufficient short term assets to cover its short term liabilities. Indeed, that Net Receivables are only $278.8 million while Accounts Payable are $1.145 billion.

Also, the total non-current liabilities of $12.8 billion are considerable and the Debt/Equity Ratio of 1.35 appears poor.

However, there is no reason to panic. Keep in mind that REITs differ from normal companies because they invest significant sums of money in real estate to grow their portfolios. As a result, they are generally highly leveraged and average Debt/Equity among REITs is 366%, while the average Debt/Equity of Real Estate Management Funds is 164%.

Once you take this into consideration, VTR’s Debt/Equity of 135% is actually very reasonable. This limited leverage constitutes one reason why the company may be able to weather the current storm.

  • DEBT MATURITY AND COMPOSITION

The calendar below reveals significant debt maturity between 2022-2026. Considering that revenues and EBITDA are increasing (and EBITDA is $1.8 billion), it appears that the company is well prepared to pay off these debts.

I have included the table below for those interested in analyzing the composition of the company’s debt. The majority of VTR’s debt is tied up in $8.5 billion of Senior Notes with a fixed 3.7% rate. This appears slightly high given that senior notes usually come with low rates because they are the first debts to be paid back in case of bankruptcy. We also notice $1.9 billion of variable rate debt but this should not pose a problem because the Fed just lowered rates to nearly zero.

It is important to mention that Fitch recently reaffirmed VTR’s Investment-Grade Credit Rating of ‘BBB+’, although it understandably revised the Rating Outlook to Negative.

INVESTMENTS & CASH FLOW

  • INVESTMENTS

It is very important for REITs to invest. Investments allows them to grow their real estate portfolio and increase their revenues by leasing the new properties.

VTR’s 2019 annual report states that “In 2019, Ventas made, committed to or closed nearly $4 billion in high-quality investments“. Indeed, the Supplemental 4Q19 states that “Total 2019 Investments” are $3.892 billion.

  • CASH FLOW

VTR’s Cash Flow is steady, with operating cash flow consistently above $1.3 billion every year since 2016. You’ll notice that the company’s Free Cash Flow is in decline since 2016 due to significant investments. In 2019, VTR invested $1.5 billion in cash. Thus, the decrease in FCF is justified as it went towards acquisitions that could boost the future financial results.

THE DIVIDEND

VTR pays a yearly dividend per share of $3.17, which represents an attractive 10.13% dividend yield. Even better, the dividend has been growing for 10 years so investors should not be worried about its safety. The dividend payout ratio of 95.82% is high but well covered by the company’s cash flow.

Despite the coronavirus panic, VTR has not cut its dividend. The latest ex-dividend date was March 31st, 2020, with payment of $0.795 per share on April 14th, 2020.

Until the coronavirus pandemic broke out, Ventas Inc was a well performing REIT.

The coronavirus has understandably caused a wave of panic selling due to uncertainty surrounding the future of senior housing. However, I believe that long term demand for senior housing will eventually return once the crisis is over and proper hygiene measures implemented. It is a question of when rather than if.

Indeed, in Fitch”s own words, “the affirmation [of BBB+ rating] also reflects Fitch’s view that VTR has sufficient liquidity to manage through heightened volatility in the capital markets“. Who am I to contradict one of the top rating agencies?

Thus, dividend investors with an appetite for risk should seriously consider purchasing this REIT while the price remains low. The high dividend yield plus the possibility of significant capital gains means that the reward could outweigh the risks.

I expect the share price to remain volatile until the crisis is over, so as always, you should spread out your investment over several weeks to hedge against any potential market drops.

VERDICT:
STRONG BUY <$30: Chance of significant capital gains
GOOD BUY <$40: Chance of reasonable capital gains
$50-$60 range: Buy for the dividend.


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DISCLAIMER: This is not financial advice. Do your own research before investing in any asset.

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